Equity REITs

FIN 460

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• Real estate company/trust• Listed or private• Tax exemption• Created to allow retail investors access to

commercial real estate• Real estate financing vehicle

WHAT IS A REIT?

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• Asset requirement:

• At least 75% in real estate assets

• Income requirement:

• At least 75% of gross income from real estate

• Distribution requirement:

• 90% of taxable income

• Held by minimum 100 persons

• No more than 50% held by 5% or fewer

REIT REQUIREMENTS

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TYPES OF REITS

• Equity REIT

• Mortgage REIT

• Hybrid REIT

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• 1986 Tax Act

• Internal management

• Property management

• Operating companies

• REIT Modernization Act (1999)

• Taxable REIT subsidiaries (TRS)

THE NEW REITS

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• Organizational structure

• Avoid capital gains tax

• Operating partnerships (OP) units in REIT

• DownREIT

UPREIT

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• Specialized versus diversified• Property types• Investment criteria• http://

www.reit.com/Videos/Raising-Capital-Not-a-Problem-for-REITs.aspx

REIT INVESTMENTS

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• Problems of reporting earnings as measure of cash flow

• REIT’s free cash flow?• FFO as performance measure• FFO=NI-Capital gain/loss+Depreciation• FFO can be affected by, e.g. TI & free rents,

leasing commissions, straight-line rents, other income

OPERATING PERFORMANCE

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• AFFO as alternative

• AFFO = FFO-Recurring capital expenses-Amortization of TI-Amortization of leasing commissions-Adjustments for rent straight-lining

• Not commonly reported; calculations differ

OPERATING PERFORMANCE

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• Growing income from existing properties

• Growing income from acquisitions

• Growing income from development

• Growing income from services

• Financial engineering

REITS AND GROWTH

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• Wave of IPOs in early 90s• Mortgage debt and equity• Transition from mortgage debt to unsecured

publicly traded debt• Bond ratings• Credit lines • DJV

REIT CAPITAL STRUCTURE

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• REITs and capital structure theory

– Trade-off theory

– Pecking order theory

– Market timing

– Different types of capital for different uses

– Pre-issuance capital structure affects issuance

choices

REIT CAPITAL STRUCTURE

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http://www.reit.com/Videos/IPO-Market-More-Challenging-for-REITs.aspx

REIT IPO

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• Advantages– Arbitrage– Access to capital– Stock options as management incentive– Liquidity

– Dominance of preferred equity– Timing of REIT IPO– Overvalued?

GOING PUBLIC

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• Wave of going privates

• Reasons for going private?

GOING PRIVATE

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• Mortgage debt• Unsecured debt• Credit lines

REITS AND DEBT

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• Acquisition joint ventures

• Development joint ventures

• Dispositional joint ventures

REITS AND JV

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• Behaved like bonds in the past

• Behave like real estate and stock

• Cointegrated with direct real estate index (NCREIF)

• REITs in S&P 500 behave more like stock (increased correlation)

ARE REIT REAL ESTATE OR STOCKS OR BONDS?

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• Direct versus indirect real estate investment

• Access to investment grade property

• Liquidity

• Professional management

• Tax-exemption (similar to direct investor)

• High dividend yield

REITS AS AN INVESTMENT

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• Correlations of REITs with other asset

• Diversification

– Property type

– Geographically

– Economic base

• Value versus bond proxy REITs versus blue chip REIT

• REIT returns lead direct real estate returns

REITS AS AN INVESTMENT

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• Individual investors– Baby boomers

• Institutional investors• REITs have grown in market cap• Joined S&P500, 400 and 600• All property types available• Increased liquidity• Professionalism• Alternative to direct investment

REIT INVESTORS

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• Which REIT sectors performed best in the last years?

• http://www.reit.com/Videos/Multifamily-Momentum-Will-Continue.aspx

• REIT performance compared to other assets

• Overview of REIT performance by sector

PERFORMANCE OF DIFFERENT TYPES OF REITS

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• Factors–Management– Access to capital and effective deployment– Balance sheet strength– Sector/geographical focus and expertise– Insider stock ownership– Dividend payout ratio– Absence of conflicts of interest

VALUING A REIT

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• Industry level

– High interest rate

– Property markets, e.g. overbuilding

– Capital market access

– Legislation

ISSUES AFFECTING REITS

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• Individual level

– Local recessions

– Changing consumer and business preferences

– Credibility (http://www.reit.com/Videos/Succession-Plans-Coming-in-Place-for-REITs.aspx)

– Balance sheet

– Small market cap

ISSUES AFFECTING REITS

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• Transparency?

• Dividend discount (growth) model

• FFO multiple

• NAV

VALUING A REIT

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• Agency problems and governance

• Market sentiment

• Spill over effects

• Herding

BEHAVIORAL ISSUES AND REITS

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• http://www.reit.com/Videos/Sustainability-Improves-Bottom-Line.aspx

• Sustainability• M&A• Internationalization• http://

www.reit.com/Videos/Specialty-REITs-Ready-to-Expand-in-Scope.aspx

• More sectors

REIT TRENDS

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• http://www.reit.com/Videos/Private-REIT-Invests-in-Affordable-Housing-Communities.aspx

• Mercy Corps REIT, Lent, Portland• Single family REIT

REIT TRENDS